I'm still struggling with the larger question of how much to allocate to bonds vs stocks, but my target is between 8%-9% annual growth with 7%-10% standard dev. Right now the portfolio looks like this:

20% SMLF - iShares Edge MSCI Mltfct USA SmCp ETF
15% ISCF - iShares Edge MSCI Mltfct Intl SmCp ETF
5% EMGF - iShares Edge MSCI Multifactor EmMkts ETF
60% Cash - I'm going to use CD's and treasuries (or tr. funds) to control for volatility.
(I'm okay taking a bit of a risk on the lower AUM and trade volume of these newer funds because I only need to rebalance once a year for the next 10 years or so. )

With interest rates still bouncing around near the bottom it's hard to hit my objective with a 40% allocation to stocks, so for purposes of this exercise I'm willing to stretch that to 50/50 to hit my objective.

Anyway, from what I understand, those funds have zero overlap and address the small/value/mom/profitability factors, though fairly trim on mom. But there's no carry in there for instance. What funds could help me hit my objective? I don't have access to much from AQR from Fidelity, nothing from Stone Ridge and I don't think DFA either, so alternatives would need to have greater retail availability.

I'm still struggling with the larger question of how much to allocate to bonds vs stocks, but my target is between 8%-9% annual growth with 7%-10% standard dev. Right now the portfolio looks like this:

20% SMLF - iShares Edge MSCI Mltfct USA SmCp ETF
15% ISCF - iShares Edge MSCI Mltfct Intl SmCp ETF
5% EMGF - iShares Edge MSCI Multifactor EmMkts ETF
60% Cash - I'm going to use CD's and treasuries (or tr. funds) to control for volatility.
(I'm okay taking a bit of a risk on the lower AUM and trade volume of these newer funds because I only need to rebalance once a year for the next 10 years or so. )

With interest rates still bouncing around near the bottom it's hard to hit my objective with a 40% allocation to stocks, so for purposes of this exercise I'm willing to stretch that to 50/50 to hit my objective.

Anyway, from what I understand, those funds have zero overlap and address the small/value/mom/profitability factors, though fairly trim on mom. But there's no carry in there for instance. What funds could help me hit my objective? I don't have access to much from AQR from Fidelity, nothing from Stone Ridge and I don't think DFA either, so alternatives would need to have greater retail availability.

Thanks in advance!

If your goal for the next 10 years is an expected return of 9% with expected volatility of 9% then you need a miracle not a factor fund.

"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

I'm still struggling with the larger question of how much to allocate to bonds vs stocks, but my target is between 8%-9% annual growth with 7%-10% standard dev. Right now the portfolio looks like this:

20% SMLF - iShares Edge MSCI Mltfct USA SmCp ETF
15% ISCF - iShares Edge MSCI Mltfct Intl SmCp ETF
5% EMGF - iShares Edge MSCI Multifactor EmMkts ETF
60% Cash - I'm going to use CD's and treasuries (or tr. funds) to control for volatility.
(I'm okay taking a bit of a risk on the lower AUM and trade volume of these newer funds because I only need to rebalance once a year for the next 10 years or so. )

With interest rates still bouncing around near the bottom it's hard to hit my objective with a 40% allocation to stocks, so for purposes of this exercise I'm willing to stretch that to 50/50 to hit my objective.

Anyway, from what I understand, those funds have zero overlap and address the small/value/mom/profitability factors, though fairly trim on mom. But there's no carry in there for instance. What funds could help me hit my objective? I don't have access to much from AQR from Fidelity, nothing from Stone Ridge and I don't think DFA either, so alternatives would need to have greater retail availability.

Thanks in advance!

If your goal for the next 10 years is an expected return of 9% with expected volatility of 9% then you need a miracle not a factor fund.

I think your comment could be helpful, but you didn't supply any data. In a 50/50 configuration, with, say 3% - 5% yield on the bond side, that would be 1.5% - 2.5% of the return. That leaves me 5.5%-6.5% of the return to make up. That's 11%-13% on the equity side. Per Larry's factor book, 1927-2015 size + value delivers 8.1%. I have a few percent to make up, though '93 - '15, DFA funds in this space delivered around 10%.

If your goal for the next 10 years is an expected return of 9% with expected volatility of 9% then you need a miracle not a factor fund.

I think your comment could be helpful, but you didn't supply any data. In a 50/50 configuration, with, say 3% - 5% yield on the bond side, that would be 1.5% - 2.5% of the return. That leaves me 5.5%-6.5% of the return to make up. That's 11%-13% on the equity side. Per Larry's factor book, 1927-2015 size + value delivers 8.1%. I have a few percent to make up, though '93 - '15, DFA funds in this space delivered around 10%.

One place to start with a reality check would be to investigate how likely it has been historically to get that much return from that much volatility.

Over ten-year periods, balanced funds have averaged a Sharpe ratio of about 0.51 or so. A Sharpe ratio of 0.65 would be a tremendous success in many market environments.

An expectation of 8.5% returns and 8.5% volatility would imply a Sharpe ratio of 0.76, which is not impossible (so maybe miracle was a strong word) but it will require being incredibly lucky in choosing the right assets in the right weights.

Is it possible? Sure. Would I build a financial plan around it? Definitely not.

Trying to predict returns is fraught with problems, but most institutional investors are assuming about 7% returns for US stocks and about 9% for ex-US stocks over the next decade. Treasuries give you maybe 3%. Even assuming that the multifactor funds you choose give you an extra boost of 1.5% over broad markets (which is an optimistic assumption, IMHO) I don't see how a reasonable expectation for portfolio returns of 8.5% could be built on anything less than 75% equities. The iShares funds aren't terribly style pure, by the way, and even if they were we can observe that having NEGATIVE factor premiums over periods of ten years isn't uncommon.

In short, you'd need multiple unlikely events to go your way. To me, that doesn't seem like the foundation of a good median expectation.

"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

If your goal for the next 10 years is an expected return of 9% with expected volatility of 9% then you need a miracle not a factor fund.

I think your comment could be helpful, but you didn't supply any data. In a 50/50 configuration, with, say 3% - 5% yield on the bond side, that would be 1.5% - 2.5% of the return. That leaves me 5.5%-6.5% of the return to make up. That's 11%-13% on the equity side. Per Larry's factor book, 1927-2015 size + value delivers 8.1%. I have a few percent to make up, though '93 - '15, DFA funds in this space delivered around 10%.

One place to start with a reality check would be to investigate how likely it has been historically to get that much return from that much volatility.

Over ten-year periods, balanced funds have averaged a Sharpe ratio of about 0.51 or so. A Sharpe ratio of 0.65 would be a tremendous success in many market environments.

An expectation of 8.5% returns and 8.5% volatility would imply a Sharpe ratio of 0.76, which is not impossible (so maybe miracle was a strong word) but it will require being incredibly lucky in choosing the right assets in the right weights.

Is it possible? Sure. Would I build a financial plan around it? Definitely not.

Trying to predict returns is fraught with problems, but most institutional investors are assuming about 7% returns for US stocks and about 9% for ex-US stocks over the next decade. Treasuries give you maybe 3%. Even assuming that the multifactor funds you choose give you an extra boost of 1.5% over broad markets (which is an optimistic assumption, IMHO) I don't see how a reasonable expectation for portfolio returns of 8.5% could be built on anything less than 75% equities. The iShares funds aren't terribly style pure, by the way, and even if they were we can observe that having NEGATIVE factor premiums over periods of ten years isn't uncommon.

In short, you'd need multiple unlikely events to go your way. To me, that doesn't seem like the foundation of a good median expectation.

It's an excellent point about the volatility. Again, going with what Larry has mentioned in his books, in one passage

"A portfolio allocated 20% to the S&P 500, 20% to the Fama-French US Small Cap Value Research Index, and 60 percent to five-year U.S. Treasury Notes produced an annual return of 8.9% with a standard deviation of 10.4%" based on data 1927-2015 with annual re-balancing. So my standard deviation is off, though in truth I'd take a target return of 7%-8% for that with an 8% - 9% standard deviation.

I'll be a bit more direct about a piece of my question though: what would be a good implementation of factors that are missing from my portfolio? I'm particularly interested in carry and maybe some diversification into something like reinsurance/risk variance/alternative lending, but I don't have access to most AQR funds or any from StoneRidge.

"A portfolio allocated 20% to the S&P 500, 20% to the Fama-French US Small Cap Value Research Index, and 60 percent to five-year U.S. Treasury Notes produced an annual return of 8.9% with a standard deviation of 10.4%" based on data 1927-2015 with annual re-balancing. So my standard deviation is off, though in truth I'd take a target return of 7%-8% for that with an 8% - 9% standard deviation.

I think that the portfolio Larry mentioned is interesting as a theoretical exercise, but the days of 6-7% bond returns and 12% equity returns are not days I expect to see over the next 10 years.

"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Have you looked at Vanguard's factor funds?
I agree with others that your return expectations are too high.

You know I haven't looked at them closely. Thanks for bringing it up. I'm starting to drift into the direction of BlackRock's target date multifactor funds. Naturally you cede control when you do this, but the simplicity begins to appeal. It also *may* be cost effective.

I appreciate your critique "expectations are too high" to be sure. It's worth pointing out that I'm targeting, not expecting. If someone says "the data supports only half that return at twice that volatility" I am down with that. I'll gladly make an evidence-based adjustment. So I'd really appreciate a data-based explanation. It's really the thing that's drawn me here to Bogleheads to begin with. Less snark and more data wins the day

I think a lot of what many have in mind is the interest rate climate. It seems to me the data supports the factors through good times and bad, black swans notwithstanding (though somewhat mitigated). But Larry's recommendation to use CD's and Treasuries to mitigate volatility is a sticking point for many, and perhaps even for me. The 30-year bond bull market in my mind complicates the use bonds in modern portfolio theory. Averaging bond yields from say 1963 to now may give you 6-ish percent average, but even with rising rates we are at half that figure still. If you are using a "Black Swan" technique where Treasuries control volatility, it seems it should come with a lot more discussion about what bond yields must be to expect returns over 5/10/20/30 years. On a day like today, I'm actually not minding my current allocation to cash so much, but I need a 10-30 year strat. Retirment comes in about 10. A portfolio at about 7%-9% (maybe even 6% with a boatload of contributions) will suffice.

Has this reliance on the 6%+ yield needed to make a Larry-type portfolio work been discussed here in depth before?

"A portfolio allocated 20% to the S&P 500, 20% to the Fama-French US Small Cap Value Research Index, and 60 percent to five-year U.S. Treasury Notes produced an annual return of 8.9% with a standard deviation of 10.4%" based on data 1927-2015 with annual re-balancing. So my standard deviation is off, though in truth I'd take a target return of 7%-8% for that with an 8% - 9% standard deviation.

I think that the portfolio Larry mentioned is interesting as a theoretical exercise, but the days of 6-7% bond returns and 12% equity returns are not days I expect to see over the next 10 years.

I strongly sympathize with this, as I mentioned in my last post, mostly on account of the bond returns. I know valuations are very high in the US markets right now, and that sets up the forward PE to be pretty dismal, but as I understand it, diversification across factors, across asset classes, US/international/EM, currencies, etc allows you from a data driven view to anticipate likelihood of outperformance of benchmarks per factor at around 80%-95% over the span of 10+ years. It's the bond piece I feel much more dicey about.

Is it a gut feel or a notion that leads you to your conclusions about the 10yr return on equities? Something else? Or do you think the data doesn't support factor-based returns over that interval?

"A portfolio allocated 20% to the S&P 500, 20% to the Fama-French US Small Cap Value Research Index, and 60 percent to five-year U.S. Treasury Notes produced an annual return of 8.9% with a standard deviation of 10.4%" based on data 1927-2015 with annual re-balancing. So my standard deviation is off, though in truth I'd take a target return of 7%-8% for that with an 8% - 9% standard deviation.

I think that the portfolio Larry mentioned is interesting as a theoretical exercise, but the days of 6-7% bond returns and 12% equity returns are not days I expect to see over the next 10 years.

I strongly sympathize with this, as I mentioned in my last post, mostly on account of the bond returns. I know valuations are very high in the US markets right now, and that sets up the forward PE to be pretty dismal, but as I understand it, diversification across factors, across asset classes, US/international/EM, currencies, etc allows you from a data driven view to anticipate likelihood of outperformance of benchmarks per factor at around 80%-95% over the span of 10+ years. It's the bond piece I feel much more dicey about.

Is it a gut feel or a notion that leads you to your conclusions about the 10yr return on equities? Something else? Or do you think the data doesn't support factor-based returns over that interval?

I'm not sure what you're referring to when you say "likelihood of outperformance of benchmarks per factor at around 80%-95% over the span of 10+ years", but when you are constrained to a long-only portfolio you're never going to get a full 1.00 load on every factor.

SMLF has loads ranging from 0.18 on quality to 0.64 on size. Altogether, the (loads * factor premia) + alpha for a fund like SMLF might give you an expected total equity risk premium of 8% or 9% versus 5% for the total market. The other MSCI factor funds end up with a factor loads that are similar or lower. Let's call the average premium 8%.

Add that to 8% premium the risk-free rate (let's call it 1.85%, which is roughly the 10 year forecast from BlackRock), and you've got total expected returns for your factor funds of 9.85%.

A portfolio that is 60% bonds might give you 6% expected returns if you get lucky and all the factors give you what you hope for.

"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

"A portfolio allocated 20% to the S&P 500, 20% to the Fama-French US Small Cap Value Research Index, and 60 percent to five-year U.S. Treasury Notes produced an annual return of 8.9% with a standard deviation of 10.4%" based on data 1927-2015 with annual re-balancing. So my standard deviation is off, though in truth I'd take a target return of 7%-8% for that with an 8% - 9% standard deviation.

I think that the portfolio Larry mentioned is interesting as a theoretical exercise, but the days of 6-7% bond returns and 12% equity returns are not days I expect to see over the next 10 years.

I strongly sympathize with this, as I mentioned in my last post, mostly on account of the bond returns. I know valuations are very high in the US markets right now, and that sets up the forward PE to be pretty dismal, but as I understand it, diversification across factors, across asset classes, US/international/EM, currencies, etc allows you from a data driven view to anticipate likelihood of outperformance of benchmarks per factor at around 80%-95% over the span of 10+ years. It's the bond piece I feel much more dicey about.

Is it a gut feel or a notion that leads you to your conclusions about the 10yr return on equities? Something else? Or do you think the data doesn't support factor-based returns over that interval?

I'm not sure what you're referring to when you say "likelihood of outperformance of benchmarks per factor at around 80%-95% over the span of 10+ years", but when you are constrained to a long-only portfolio you're never going to get a full 1.00 load on every factor.

SMLF has loads ranging from 0.18 on quality to 0.64 on size. Altogether, the (loads * factor premia) + alpha for a fund like SMLF might give you an expected total equity risk premium of 8% or 9% versus 5% for the total market. The other MSCI factor funds end up with a factor loads that are similar or lower. Let's call the average premium 8%.

Add that to 8% premium the risk-free rate (let's call it 1.85%, which is roughly the 10 year forecast from BlackRock), and you've got total expected returns for your factor funds of 9.85%.

A portfolio that is 60% bonds might give you 6% expected returns if you get lucky and all the factors give you what you hope for.

I like where you are going with this. Where do you get your 5% from the total market though?

I think it's always wise to carefully consider what Taylor has to say.

[*]The risks of factor investing are usually understated (perhaps, severely so), and the diversification benefits tend to be overstated.

[*]Because factor returns substantially deviate from normality and because correlations between factors are not constant over time, a multi-factor portfolio may retain exposure to the risk drivers of the individual factors. Thus, portfolios invested in multiple factors may still experience severe drawdowns and decade-long periods of underperformance.

Thank you for this reply, Taylor. I read the first post in this long list, but I'm afraid I ran into some headwinds with trying to understand your points. As I understood it, you made these claims:

1. "I am skeptical, primarily because nearly all academic research about investing is based on past performance which experienced investors and the government warn us against. "

Is it your claim that if "experienced investors" and "the government" warn us against investing based on past performance, then we should be skeptical of attempting to assigning variance of future returns based on any evaluation of past returns, no matter how well-reasoned/researched?

2. "A study by Rick Ferri & Alex Benke found that an all index 3-fund market portfolio outperformed active portfolios 82.9% of the time during a 16-year period (1997-2012). That's good enough for me."

I take your meaning here that the past performance of an all index 3-fund market portfolio's performance is cause for investing in that same portfolio because it's past performance bodes well for future returns. This seems to contradict your first point wholesale.

If these weren't your claims, could you please help me understand what they are/were?